Something for the Weekend

I am pretty much up to my ears at the moment with, of all things, a country outlook/analysis on Chile. This means that I have not exactly had time to do my usual tour of the recent economic data from the Eurozone and Eastern Europe. I hope to redeem myself at a later point next week.

Meanwhile I thought that I would round up this week at Alpha.Sources with a couple of pointers on a range of recently debated topics.

Hank Paulson, his Bazooka, and a European Perspective

Good old Hank Paulson certainly seems to be under the spotlight at the moment (see also my last post), not least in these two Bloomberg pieces. As could have been predicted, it is all about who and what which will eventually make it under the soothing umbrella of the incoming treasury bail-out.

At stake if Paulson does intervene: the fate of worldwide bondholders of $5.2 trillion of agency and mortgage-backed debt and scores of large banks, insurers and pension funds that own the firms' common and preferred shares

Paulson's choices probably include buying Fannie's and Freddie's bonds, a special class of preferred shares or preferred shares convertible into common stock, analysts and investors said. The terms and conditions of any purchases would put the government ahead of other creditors and stockholders, while ensuring that bondholders are protected, they said.

``He's had zero clarity on this whole issue, and until the market knows where Hank's going to be in the capitalization structure, then it gets worse not better,'' said Paul McCulley, a fund manager at Pacific Investment Management Co., which has the world's largest bond fund.

The only real interesting point here seems to be the preferred stock holders [1] and whether they will make it to drink from the treasury's trough. I am laboring under the assumption here that the common stockholders are screwed whereas the bondholders are protected; this latter point being the whole point with whatever they decide to do.

On a similar note, Edward asks the interesting question of whether the Spanish cedulas might constitute Europe's very own Fannie Mae and Freddie Mac with the neat exception that the Eurozone does not have an equivalent to Paulson, nor a governing body to issue blank checks, to clean up the mess.

Basically the Spanish banking system has a problem just as large in its way as the FannyMae and FreddyMac one, since they have 300 billion euros or so in ceduas hipotecarias to refinance over the next 5 years (not counting all the other RMBS's which are knocking about, which have equal or greater value, even if the term on these may not present the same sort of problem), starting with 40 billion or so this autumn

But Spain has no Hank Paulson with his bazooka to come to the rescue. And as we can see in the US arming up the bazooka can simply make its use unavoidable,

Having followed the situation up closely thanks to Edward's ardent analysis I, too, am convinced that the cedulas eventually will need an answer from Bruxelles. The main point would be that the ECB simply cannot keep on shouldering it through expansions of liquidity provisions and by derivative its balance sheet.  At the end of the day then, they are first and foremost lending money in a situation where you really need, US style, a Bazooka.

Of course, I would not put too many feathers in Paulson's hat. Consequently , the potential for uncertainty  is very important as also expressed by this quote taken from the Bloomberg pieces linked above:

Explicit government support leaves the GSEs in an unpredictable situation,'' said Alec Phillips, an economist in Goldman Sachs Group Inc.'s Washington office and a former staffer on the Senate Finance Committee. Fannie and Freddie ``do not yet have additional public sector capital, but this possibility may hinder attempts to raise private capital,'' he said.

Like I said in the post immediate preceeding this one; at this point, investors need a clear answer on the future structure of the GSEs. In the cedulas' case there is also the small point that they are not only on sitting on the books; they are also supposed to be liquid to some degree or the other. This is to say that they need to be re-financed within the next 5 years and it is in this light specifically that they are burning holes in the small cajas' balance sheet since what is really the future discounted cost of this operation?

Basically, this is very similar to the Fannie/Freddie situation where the debt roll-over due in a few months WILL be the famous straw that breaks the camel's back I think.

Edward also latches on to the whole point about Northern European tax money paying for the economic illnesses of Southern Europe. Personally, I think that Edward is right to argue that;

    (...) the ECB money isn't precisely taxpayers money at this point. They are simply making loans from the resources they have via the reserves deposited with them through the eurozone banking system, and they have some money of their own via seinorage, I guess. And they are lending it, not giving it. The point at issue is simply that they are accepting what are really junk bond status cedulas as if they had investment grade.

This may certainly be worse enough in the sense that the ECB like the Fed is using its balance sheet to harbour all kinds of dubious assets with highly uncertain future value and cash flow prospects. Or put in another way; those cedulas entering the ECB's vaults will most like never leave again.

Can the Buck Stand its Ground?

Another topic which is still high on the agenda amongsts market participants has been the recent ascend of the US dollar, a theme I also latched onto in the ensuing week after the Buck had jumped from the ashes as the proverbial Phoenix. As it happens, Macro Man recently returned from holiday and with that naturally came a long and thoughtful inquiry into the intepreation of recent market moves.  It is highly recommended to have a closer look at this piece  whose bottom line indicates that MM believes something, if only a little bit, has changed.

The degree to which the dollar can "buck up" from here will, in all likelihood, ultimately depend on the extent to which the US economy and financial system can recover from the current crisis; issues which seem unlikely to see a quick resolution.

Still, the dollar moving from a one-way bet to a two-way bet is a significant change, and one that Macro Man intends to heed in his investment strategy. This month Macro Man has already taken the biggest dollar long bet that he's had in two or three years, and while he can certainly contemplate going short again, perhaps soon, from his perspective the era of the "all-in" bet from the short side is over.

I would also mention Brad Setser's fine piece to accompany Macro Man's holiday opener. Not all feel sure about the USD though. Stefan Karlsson is on record for calling this a sucker rally and also others remain duly skeptical as to the recent and new found vigour of the USD.

The question of timing obvious always comes into play here since how long does the USD need to stay strong (e.g. against the AUD, Kiwi and most prominently the EUR) before we can say that it is back? I will leave that for you to decide over the weekend.


[1]: You know, those things which your corporate finance teacher told you should be considered debt; well, now we will see whether he is right